UMA is a decentralized platform focusing on financial agreements to enable universal market access through synthetic assets.
In the centralized finance (CeFi) sector, synthetic assets allow investors to take advantage of an asset’s price movements without necessarily interacting with it. For example, an investor can interact with bonds and stocks through derivative products such as options and futures. In addition, synthetics enable access to multiple financial routes.
Synthetic assets are also available in the decentralized world. Mostly referred to as cryptocurrency synthetic assets, they allow virtual currency investors to interact with CeFi while still being able to enjoy the benefits of distributed ledger technology (DLT).
Crypto synthetic assets are part of the decentralized finance (DeFi) space. And as DeFi gains momentum, projects are being born to power every corner. A good example of a phenomenal DeFi project is UMA.
UMA is developed by Risk Labs, with a focus on bringing equality in the financial sector. The team believes freedom and universal access should influence the industry instead of censorships and pre-existing social capital.
The top UMA investors include Placeholder, BainCapital Ventures, Blockchain Capital, Two Sigma Ventures, Coinbase Ventures, Dragonfly Capital, Box Group, and Fintech Collective.
What is UMA?
UMA is a decentralized platform focusing on financial agreements to enable universal market access through synthetic assets. It powers self-enforcing smart contracts using public distributed systems such as Ethereum. Ideally, the platform mimics similar offerings in the conventional finance world.
However, unlike in CeFi, a smart contract on the network only uses economic incentives as security. The protocol employs two technologies to achieve its vision.
Two Crucial UMA Technologies
Priceless Financial Contract Designs
This part of the network’s technology drives secure, efficient, and fast Ethereum-based synthetic derivatives. The agreements are ‘priceless’ because they are enhanced to employ off-chain price feeds and ensure that counterparties provide the right amount of collateralization.
To warrant a properly guaranteed position, the platform rewards external parties for spotting an inefficiently collateralized position.
Data Verification Mechanism (DVM)
UMA’s DVM provides services as a blockchain-based oracle. It’s used to check if positions are adequately collateralized among other price requests from connected contracts. Instead of a simple request-and-supply connection, price requests are subjected to a vote.
Holders of the system’s native coin, UMA, use a historic timestamp to vote on a price identifier’s value. The process takes between two and four days.
Instead of computing the voting process’s outcome after the voting period, the votes are revealed and delivered to the requesting financial contract. Based on the votes, the contract decides on the interaction between the pledge and counterpart. The long voting period makes the DVM supplementary to priceless agreements.
With malicious actors masquerading as trusted parties, DVM discourages corruption by making it costly to corrupt the DVM rather than profit from the act.
How UMA Works (Using an Example)
Since UMA is all about derivatives, it includes party agreement, automatic enforcement, and instant settlement.
Let’s take the example of Apple shares.
- Party agreement – James thinks the price of the shares will increase in the next three months. Jackie, on the other hand, is of a contrary opinion. James and Jackie enter into a contract developed on UMA. To ensure that they don’t change their minds, they both provide a 10 percent margin.
- Automatic enforcement – In the following months, the price of Google shares takes a dip. UMA uses its oracle to verify the movement. To cover his margin position, James deposits more funds based on how far the price falls.
- Instant settlement – Three months are over, and the shares’ price has dipped by 30 percent. Jackie wins the bet, and the contract is instantly settled.
UMA Synthetic Tokens
These are tokens backed by a surety. As such, their value depends on the underlying asset. Synthetic tokens mirror features found on futures, collateralized loans, and prediction markets.
For example, they can be used in tracking the number of Metamask downloads and monitoring the future value of assets locked on DeFi platforms.
UMA’s synthetic tokens are built using priceless financial contracts. These tokens do not utilize an on-chain oracle to provide price feeds. Its creators are called sponsors.
Sponsors are rewarded for properly insuring their positions. Disputes arising from collateralization are subjected to a dispute process with the UMA DVM oracle service supplying data.
Note that a single DVM contract can handle several synthetic tokens. A token sponsor can be forced to create a minimum number of tokens against a treaty template to ensure that liquidations and disputes can take care of transaction fees.
Creating and Launching a New Synthetic Token
Launching a token on UMA is done on a financial contract template. UMA allows anyone to create a contract template and token.
An agreement has parameters such as the price feed, token expiration, and collateralization requirements. Synthetic tokens are over-insured at 120 percent based on the price fee the token is built to track.
Generally, the UMA smart contract holds the security while disbursing a synthetic token to the token sponsor. An agreement follows the network’s global assurance ratio to determine the right amount of surety.
As such, the first token sponsor may not require high collateral. However, the assurance by subsequent token creators is based on a ratio of all un-liquidated pledges.
A token sponsor can withdraw excess surety either through speedy or slow withdrawal mechanisms. A fast mechanism can be initiated to remove extra collateral instantly. The slow mechanism can be done when the sponsor wants to reduce its global guarantee ratio.
It can render the creator insolvent. In a slow withdrawal process, token holders can exit their positions based on their understanding of the effects of the sponsor reducing their guarantee.
By powering universal market access, UMA interfaces DeFi with CeFi by taking advantage of the decentralized platforms such as Ethereum. UMA powers a complete synthetic market by providing a platform to create synthetic tokens complete with liquidation and settlement rules.
By using off-chain data feeds, UMA’s priceless financial contracts are less prone to oracle attacks. However, where oracles are needed, like in settling liquidations, the platform provides the DVM technology. Following a simple agreement-enforcement-settlement process simplifies the understanding of blockchain-based synthetic products.